Broker Dealer Auditing: Mastering New SEC and PCAOB Rules and - - PowerPoint PPT Presentation

Broker Dealer Auditing: Mastering New SEC and PCAOB Rules and Standards

Complying with Changed Regulatory Framework for Conducting Audits and Attesting to Internal Controls Today’s faculty features:

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Presenting a 110-Minute Encore Presentation of the Teleconference with Live, Interactive Q&A Kevin Breard, Managing Partner, Breard & Associates, Northridge, Calif. John T . Hague, Financial Services Industry Leader, McGladrey & Pullen, Chicago

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Broker Dealer Auditing: Mastering New SEC and PCAOB Rules and Standards

Kevin Breard, Breard & Associates kbreard@baicpa.com

• Nov. 5, 2014

John Hague, McGladrey John.Hague@mcgladrey.com

5

Today’s Program

Overview [Kevin Breard] Exemption Reports [Kevin Breard] Compliance Reports [John Hague] Slide 8– Slide 12 Slide 39 – Slide 50 Slide 51 – Slide 57 Slide 58 – Slide 59

6

Independent Public Accountant's Responsibility [John Hague] Slide 13 – Slide 32 Slide 33 – Slide 38 Best Practices [Kevin Breard] Access to Accountant and Audit Documentation [John Hague]

Notice

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You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.

7

OVERVIEW

Kevin Breard, Breard & Associates

8

• How may broker/dealers are registered with

the SEC as of December 31, 2011?*

• A. 4,700
• B. 5,500
• C. 6,500
• D. 8,900

▫ *Based on FOCUS reports filed for December 31, 2011

9

Overview

• How many of the 4,700 SEC registered firms are

carrying broker/dealers?

• A. 900
• B. 700
• C. 300

10

Overview

Source: Federal Registers/Vol. 78 No. 162/ Wednesday, August 21, 2013 Rules and Regulations

11

Overview

Source: PCAOB Release No 2013-006 August 19, 2013

12

Overview

EXEMPTION REPORTS

Kevin Breard, Breard & Associates

13

New SEC report

“Form Custody” for Broker/Dealers

• Who

Applies to all B/Ds

• When

4th quarter 2013

• Due

17th business day after quarter

• Filed

With FOCUS DEA

• Have to audit? No

14

Form Custody

15

• Beginning December 31, 2013, what entity will

require a copy of your audited financial statements?

• A. Affordable Care Act Insurance Exchange

(Online)

• B. Vatican (Rome, Italy)
• C. United Nations (New York, NY)
• D. Securities Investor Protections Corporation

(Washington, DC)

16

New SEC Rule Issued August 2013

• Net capital rules
• Rule 15c3-1

▫ Requirement to deduct from net worth certain liabilities or expenses assumed by third parties ▫ New paragraph (c)(2)(i)(F) ▫ If B/D shifts (offloads) expenses/liabilities to a third party that lacks the resources to pay, then B/D must take a charge to net capital

1/4 17

Final Hot Topics

• Expense sharing agreement

▫ Parent – sub (B/D) ▫ Reasonable allocation

• All expenses on books to run B/D?
• Parent’s books

▫ Not audited ▫ Not made available to FINRA ▫ Solvent/liquid/creditworthy ▫ Regulator frustration

18

New SEC Rule August 2013

• Requirement to subtract from net worth certain

non-permanent capital contributions.

▫ (c) (2)(i)(G)(2) ▫ Capital contribution with intent of withdrawal within a year ▫ Then must be subtracted from net capital.

19 2/4

New SEC Rule August 2013

• Amendment to 15c3-1 Restricting Withdrawal of

Capital.

▫ 15c3-1(e)(3)(i) and 15c3-1(e)(3)(i)(A) and (B) ▫ Restrictions on withdrawal of capital ▫ Old rule 30% limit of excess capital ▫ New rule prohibits withdrawal of any excess capital ▫ Applies to withdrawal, advances, loans

20 3/4

New SEC Rule August 2013

• Broker/dealers Solvency Requirements

▫ Amends (a) of 15c3-1 ▫ Broker/dealers cease conducting business if insolvent ▫ If insolvent, notices to SEC, DEA, CFTC

21 4/4

New Rules

Carrying B/D Non-carrying B/D

• Compliance report addresses

compliance with 15c3-1, 15c3-3

• Report material weakness

internal control over compliance

• Report any instances of non-

compliance

• Exemption report.

Did claim exempt under 15c3-3

Effective June 1, 2014

22

Review Rule 15c3-3 Exemptive Provision

• (k)1: Limited business (mutual fund and/or

variable annuities)

• (k)(2)(1): “Special account” for the exclusive

benefit for customers maintained

• (k)(2)(ii): All customer transactions cleared

through another broker/dealer on a fully disclosed basis

• (k)(3): Exemption by order of the SEC

23

Two new PCAOB attestation standards

1. Examination Engagements Regarding Compliance Reports of Brokers and Dealers “Compliance Report”

• 2. Review engagements Regarding Exemption

Reports of Brokers and Dealers “Exemption Report”

24

Internal Control Report

25

PCAOB Attestation Standard #2

• Review Engagements Regarding Exemption

Reports for Broker/Dealers

▫ “Exempt Report” ▫ Applies to majority of FINRA members ▫ Fully disclosed; no customers; nickel broker/dealer

26

Assertion 2 – “Exemption Report”

• Broker/dealer statement (assertion) operates

under particular exemption (k)1, k(i), k(ii), etc)

• Auditor objective: State whether any material

modification to the assertions should be made for the assertions to be fairly stated in all material respects

• Auditors report

▫ Broker/dealer met exemption provision without exception, OR ▫ Exceptions - discuss nature and occurrence

27

• Review engagement should be coordinated with audit

financial statements.

• Auditor needs to perform inquiries, i.e. management

and those with relevant knowledge.

• Review regulatory examination regarding compliance

with exemption provision

• Review controls relevant to compliance with exemption

provision

• Review monitoring activity
• Review any known exceptions to exemption provision.

28

Representation Letter

• Must obtain
• Failure to obtain – limit on scope of review

engagement

29

Report of Independent Registered Public Accounting Firm

Introductory paragraph with no exceptions: We have reviewed management’s statements, included in the accompanying Surebet, Inc. Exemption Report, in which (1) Surebet, Inc. identified the following provisions of 17 C.F.R. § 15c3-3)(k) under which Surebet, Inc. claimed an exemption from 17 C.F.R. § 240.15c3-3: (2) (ii) (the “exemption provision”) and (2) Surebet, Inc. stated that Surebet, Inc. met the identified exemption provision throughout the most recent fiscal year without exception. Surebet, Inc.’s management is responsible for compliance with the exemption provision and its statements. Introductory paragraph with exceptions: We have reviewed management’s statements, included in the accompanying Surebet, Inc. Exemption Report, in which (1) Surebet, Inc. identified the following provisions of 17 C.F.R. § 15c3-3(k) under which Surebet, Inc. claimed an exemption from 17 C.F.R. § 240.15c3-3: (2)(ii) (the “exemption provision”) and (2) Surebet, Inc. stated that Surebet, Inc. met the identified exemption provision throughout the most recent fiscal year except as described in its exemption

• report. Surebet, Inc.’s management is responsible for compliance with the exemption provision

and its statements.

30

Report of Independent Registered Public Accounting Firm (cont.)

Our review was conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States) and accordingly, included inquiries and other required procedures to

• btain evidence about Surebet, Inc.’s compliance with the

exemption provision. A review is substantially less in scope than an examination, the objective of which is the expression of an opinion

• n management's statements. Accordingly, we do not express such

an opinion. Based on our review, we are not aware of any material modifications that should be made to management’s statements referred to above for them to be fairly stated, in all material respects, based on the provisions set forth in paragraph (k)(2)(ii) of Rule 15c3-3 under the Securities and Exchange Act of 1934. Breard & Associates, Inc. Los Angeles, California

31

Slide Intentionally Left Blank

COMPLIANCE REPORTS

John Hague, McGladrey

33

Compliance Report – Descriptions

• The Compliance Report also includes two (2)

descriptions, if applicable

1) Each identified material weakness in the Internal Control Over Compliance during and as of the end of the fiscal year 2) Any instances of non-compliance with the Net Capital and the Customer Reserve Requirement

• f the Customer Protection Rules as of the end
• f the fiscal year

34

Compliance Report – Definitions

• Internal Control Over Compliance
• Internal controls that have the objective of providing

the broker-dealer with reasonable assurance that non-compliance with the financial responsibility rules will be prevented or detected on a timely basis

• Material Weakness
• A deficiency, or a combination of deficiencies, in

the broker-dealer’s Internal Control Over Compliance such

• that there is a reasonable possibility that non-compliance

with the Net Capital and the Customer Reserve Requirement of the Customer Protection Rules will not be prevented or detected on a timely basis or

• that non-compliance to a material extent with Rule 15c3-

3, except for paragraph (e), or any Account Statement Rule will not be prevented or detected on a timely basis

35

Important Thought

• An identified material weakness in the

internal control over compliance does automatically result in a reportable instance

• f non-compliance with the financial

responsibility rules.

36

Compliance Report – Changes from Proposed Rules

• The final rules reflect two (2) changes from

the proposal:

1) Elimination of the concept of material non-compliance and compliance in all material respects 2) A narrowing of these statements and requirements from compliance with all of the financial responsibility rules to compliance the Net Capital and the Customer Reserve Requirement of the Customer Protection Rules

37

Slide Intentionally Left Blank

Independent Public Accountant’s Responsibility

Independence

• Follow SEC independence rules (Regulation S-X)
• Auditors cannot provide
• Bookkeeping or other services related to accounting

records or financial statements preparation

• Financial information systems design and implementation
• Management functions or human resources
• Certain Regulation S-X rules do not apply
• Partner rotation
• Audit committee pre-approval
• Review of the exemption report or perform an

examination of the compliance report

• The exemption and compliance reports MUST BE

prepared by the broker-dealer PCAOB independence rules pending (stay tuned)

40

Engagement of the Accountant

• Current Requirements, applicable to audits of year ends

through May 31, 2014

• Audits of broker dealers reports filed with SEC made in

accordance with generally accepted auditing standards (GAAS)

• Report on Internal Control Report prepared by the accountant
• New Rules, applicable to audits of year ends on and after

June 1, 2014

• Audits and attestation of broker dealers reports filed with SEC will

be made in accordance with PCAOB standards

• Auditor’s Report on Internal Control previously required by SEC

Rule 17a-5(g)(1) is replaced by the auditor’s Examination Report

• r Review Report, as appropriate
• The PCAOB is working to finalize the permanent inspection

program of audits of broker-dealers. The interim inspection program is anticipated to continue through 2014. 41

PCAOB Standards

• SEC amended Rule 17a-5 to state that examination of

Compliance Reports and review of Exemption Reports will be in accordance with PCAOB Standards

• PCAOB in 2011:
• Proposed Auditing Standard on Auditing Supplemental

Information Accompanying Audited Financial Statements and Related Amendments to PCAOB Standards

• Proposed Standards for Attestation Engagements Related to

Broker and Dealer Compliance or Exemption Reports

• These standards are to align attestation standards more

closely with the auditor’s responsibility under the amendments to Rule 17a-5

42

PCAOB Standards (continued)

• On October 10, 2013, the PCAOB adopted the Attestation

Standards and Auditing Standard No. 17, Auditing Supplemental Information Accompanying Audited Financial Statements

• Effective for fiscal years ending on or after June 1, 2014 (subject

to SEC approval)

• PCAOB also proposed an update to certain rules to conform to

the Dodd-Frank amendments to the Sarbanes-Oxley Act, which includes

• Rules requiring that registered firms comply with the PCAOB

standards

• Ethics and independence requirements
• These are pending final approval

43

PCAOB – Attestation Standards

• Two attestation standards that cover the

auditor’s examination regarding compliance reports and the auditor’s review regarding exemption reports of broker-dealers were adopted

• Examination Standard: Attestation Standard
• No. 1, Examination Engagements Regarding

Compliance Reports of Brokers and Dealers

• Review Standard: Attestation Standard No. 2,

Review Engagements Regarding Exemption Reports of Brokers and Dealers

44

PCAOB – Examination Standard

• Provides requirements for the auditor that

include the following:

• Obtaining sufficient appropriate evidence to opine on

the Compliance Report

• Focusing on matters that are most important to the

auditor’s conclusion regarding the statements of the broker-dealer

• Consideration of fraud risk, including the risk of

misappropriation of customer assets

• Coordination of the examination engagement with the

audit of the financial statements and audit procedures performed on supplemental information

• Description of how to report on an examination

engagement, in connection with the requirements of SEC Rule 17a-5

45

PCAOB – Review Standard

• Requires the auditor to obtain moderate

assurance about the following statements in the exemption report:

• A statement that identifies the exemptive

provisions claimed by the broker-dealer

• A statement that the broker-dealer

1) Met the identified exemption provisions throughout the fiscal year without exception OR 2) Met the identified exemption provisions throughout the fiscal year, except as described in exemption report 3) If applicable, identification of each exception with descriptions (nature and approximate date(s))

46

PCAOB – Supplemental Information

• Auditing Standard No. 17, Auditing

Supplemental Information Accompanying Auditing Financial Statements

• A new standard
• Establishes the auditor's responsibilities when

performing audit procedures and reporting on supplemental information that accompanies the audited financial statements of broker-dealers and others

• Intended to give the SEC and other users greater

confidence in the quality and consistency of supplemental information

47

PCAOB – Supplemental Information (continued)

• Requirement of the auditor:
• To determine that the supplemental information

reconciles to the underlying accounting and other records or to the financial statements

• To test the completeness and accuracy of the

supplemental information

• To evaluate whether or not the supplemental

information, including form and content, complies with the relevant regulatory requirements

48

PCAOB – Supplemental Information (continued)

• Supplemental Information means:
• Supporting schedules required to be filed pursuant to Rule

17a-5

• Supplemental information
• Required to be presented pursuant to the rules and regulations
• f a regulatory authority
• Covered by an auditor’s report on that information related to

financial statements that are audited in accordance with PCAOB standards

• Information that is
• Ancillary to the audited financial statements;
• Derived from the company’s accounting books and records; and
• Covered by an auditor’s report on that information related to

financial statements that are audited in accordance with PCAOB standards

49

Slide Intentionally Left Blank

Best Practices with Exemption Report

• Example 1

▫ $5,000 B/D can effectuate 10 (ten) proprietary trades a year.

▫ Broker/dealer has 100 trades. Exemption not met. ▫ FINRA asserts $100K B/D and assesses penalties for being below net capital.

• Example 2

▫ What could go wrong? B/D has client that walks in with stock certificate. ▫ Audit evidence – working supervisory procedures (W/S/P) promptly refuse to accept certificate or forward to a clearing firm.

51

Best Practices

• Old

▫ SEC two (2) copies

• New

▫ SEC one (1) copy, SIPC one (1)

52

Example 3

Best Practices Related parties (AU Sec 334)

• Is inquiry of management sufficient for

evaluating related party transactions?

▫ Yes ▫ No

53

Best Practices Related parties (AU Sec 334)

• After identifying related party transactions, the auditor should

apply the procedures he considers necessary to obtain satisfaction concerning the purpose, nature, and extent of these transactions and their effect in the financial statements. The procedures should be directed toward obtaining and evaluating sufficient appropriate evidential matter and should extend beyond inquiry of management.

• Procedures that should be considered include the following:

A. Obtain an understanding of the business purpose of the transaction

54

Best Practices Related parties (AU Sec 334)

• Procedures that should be considered include

the following:

B. Examine invoices, executed copies of agreements, contracts and other pertinent documents, such as receiving reports and shipping documents C. Determine whether the transaction has been approved by the board of directors or other appropriate officials.

55

Best Practices Related parties (AU Sec 334)

• Procedures that should be considered include the

following:

D. Test for reasonableness the compilation of amounts to be disclosed, or considered for disclosures, in the financial statements. E. Arrange for the audit of intercompany account balances to be performed as of concurrent dates even if the fiscal years differ, and for the examination of specified, important and representative related party transactions by the auditors for each of the parties, with appropriate exchange of relevant information. F. Inspect or confirm and obtain satisfaction concerning the transferability and value of collateral 56

Technical side

Prior Rule 17a-5 New June 1, 2014

• Rule 17a-5(d) “Annual filing of

audited financial statements”

• (d)(2) List of financial reports
• (d)(3) Support schedules, net

capital computations, reserve requirement, possession/control

• (d)(4) Reconciliation of

FOCUS to the audited net capital

• New (d)2 to combined (d)2-

(d)4

• (d)(3) Compliance Report
• (d)(4) Exemption Report
• (d)(5) “Annual Reports” new

term to replace Audit Report

• (d)(6) SIPC filing

Annual Reports 1. Audit Financial Statement with support schedule, et al

• 2. Exemption or Compliance report

57

Access to Accountant and Audit Documentation

Access to Accountant and Audit Documentation

• SEC amended Rule 17a-5 to require that each clearing broker-dealer agrees

to allow SEC and its DEA examination staff

• to review the audit documentation associated with its annual audit reports
• allow its independent public accountant to discuss findings relating to the audit

reports with the SEC and DEA

• Access to information and discussions with a clearing broker-dealer’s

independent public accountant would enhance the efficiency and effectiveness

• f Commission and DEA examinations
• This requirement is limited to clearing broker-dealers, which generally have

more complex business operations than non-carrying firms

• Request to a broker-dealer’s independent public accountant for the accountant

to discuss audit findings or for access to audit documentation must be made in writing

• SEC anticipates that it will accord confidential treatment to such documents to

the extent permitted by law

59